How Does an Interest Rate Change Affect My Student Loan?

After years of rates near zero, the Federal Reserve increased a key rate by a quarter of a percent in December 2015. For some borrowers, including those with variable-rate private student loans, that could mean slightly higher payments starting in January. In the announcement, the Fed emphasized that it would be slow to make subsequent increases.

Existing federal student loans and private loans with a fixed rate are not affected by the rate change. For these loans, your minimum monthly payment will remain the same.

Here’s what you need to know about the rate change and your student loans.

What does a rate change mean?

When the Federal Reserve changes rates, the rate that is changing is the federal funds rate. This is not the benchmark rate that determines your APR for your student loans.

It is, however, the rate that most other reference rates, such as LIBOR, tend to follow directionally. When the federal funds rate goes up, other rates go up; when it goes down, other rates go down.

The most important rate when it comes to student loans is 1-month LIBOR. That is what many student loan companies, including Earnest, use to set your APR. Earnest updates rates on the first of the month, according to the 1-month LIBOR figure published on the 25th of the prior month in the Wall Street Journal.

What loans are affected by a rate change?

If you have a variable-rate private loan, you are likely to see a change in your APR and minimum payment due when rates change. For example, if your existing APR was 2.60 percent and 1-month LIBOR increases by 25 basis points, or .25 percent, your new APR will be 2.85 percent.

Will this change my payment if I have a variable rate loan?

It depends. Your minimum payment and your monthly payment are not always the same thing if you’re in the routine of overpaying your loans every month.

There is a minimum due for every loan — and that number is often an odd-seeming number that’s precise down to the penny. If you’re paying the exact minimum due every month — for example $544.96 — you will see your payment increase to reflect a new minimum on your variable-rate loan.

However, if you’re paying more than your minimum due — for example, you have rounded up to pay $600 — your monthly payment will remain the same. What will change is the amount of your payment that’s applied to interest and the amount that applied to your principal.

For example, your new minimum due might be $588.32. You can continue to make the same payment, e.g. $600, but more of that payment will go toward interest.

With your Earnest loan, you can always view your current minimum due or adjust your payments in your dashboard under Payment Options > Change Autopay Amount.

Here are some general guidelines to consider if you’re taking a new private loan or refinancing:

Variable rates are better when:

Fixed rates are better when:

You have a shorter loan term, which limits the chances for rates to change.

You have a longer loan term, and you don’t want to be affected by moving rates.

You can handle an increased minimum payment.

You don’t want your minimum payment to increase.

You believe interest rates will decrease or stay flat in the near future.

You believe interest rates will increase in the future and you want to lock in a rate now.

If you’re applying for federal student loans, these are set with a fixed rate. However, the government will reprice new federal loan rates in July 2016.

What will happen with rates in the future?

A final thing about variable rates to keep mind: there is no limit to how much the reference rate can rise or fall in any one year, but Earnest loans do have a maximum APR.

At Earnest, any variable loan that has a term of 10 years or less has a lifetime cap of 8.95 percent. For any loan term between 10 years and 15 years, it’s 9.95 percent. Any term longer than 15 years is capped at 11.95 percent, subject to state availability.